The S&P 500 comes up very often in any conversation regarding investments. When beginner investors ask what they should invest in, the response they often get is “the S&P 500.” The S&P 500 is often the benchmark metric for many professional investors (what they compare their own portfolios to).
The S&P 500 is so important that it is often used as an indicator of the strength of the entire U.S. economy! So, before you go putting your money into this mythical S&P 500, let’s take some time to understand what it actually is.
The S&P 500, or the Standard and Poor’s 500, is a stock market index composed of the 500 largest and most profitable US publicly traded companies.
Let’s break some of those terms down:
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Standard and Poor’s: Standard and Poor’s is a company that calculates, maintains, and publishes the S&P 500 index.
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Index: An index is a basket of stocks, curated to follow certain criteria. In this case, the criteria are that these are the 500 largest and most profitable stocks in the United States.
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Largest: When we use the word large in describing a company, we are referring to something called its market capitalization. A company’s size cannot just be judged by its share price, since a company’s share price is often determined by the amount of shares it has trading in the market. There is no set amount of shares a company has to issue like 1,000 or 1,000,000. Thus, to determine the size of a company, we multiply the current market value of one share of the company with the total number of shares currently trading in the market.
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Publicly Traded: Less than 1% of all companies in the US are publicly traded, meaning that they are able to be bought and sold on the stock market. The others are called private companies. Becoming a public company is usually reserved for extremely large companies, although many of the largest companies in the US are privately owned, such as Publix, the grocery store chain, or Mars, the candy bar company.
The S&P 500 is not set in stone, and is continuously updated as different companies increase or decrease in market capitalization and profitability. The S&P 500 is market-weighted itself, meaning not all 500 companies have equal weight in the index. Usually, the bigger the company, the more influence it has in the index.
For example, if Apple stock (historically in top 10 of market capitalization) has a bad day and falls 10%, the entire S&P 500 would drop significantly more than if Domino’s Pizza dropped by that exact same 10%. Investing in the S&P 500 is usually seen as a safer equity investment since it invests in large, established companies that usually have stable revenues.
When you invest in the S&P 500, you are investing in 500 companies at once! However, just like all investments, the S&P 500 can decrease in value and is not guaranteed to provide a positive return.